As the rupee edged down to almost 59 a dollar on Tuesday last (June 11), a few points became obvious. The continuous fall in the rupee since the middle of the previous week had set new records each day, both for the new lows as well as the extent of fall over successive trading days. Terms such as “lifetime” and” historical” lows ceased to have much significance. The rupee recovered on Wednesday to close at 57.80 but started losing again on Thursday although it recovered later in the day.

The gyrations in the rupee last week are due to a number of factors, with some of it remaining in the sphere of conjecture.

In the short-term, it is necessary to counter the negative sentiment, which seems to have enveloped all financial markets. In India, the stock exchanges, too, crashed in tandem with the rupee.

Sentiment

Unfortunately, however, sentiment is something very difficult to influence, especially when there is a herd mentality among market participants.

Importers who lose out when the rupee weakens rush to cover, that is buy dollars, while exporters hold on to their dollars hoping for an even better exchange rate.

It has always been assumed that the Reserve Bank of India (RBI) will intervene even though, according the market participants, it was evident for the first time only on Tuesday, when some public sector banks sold dollars, presumably on behalf of RBI.

But intervention however robust can only yield short-term results.

The RBI Governor, D. Subbarao, has been frank enough to admit that any intervention that does not pack the desired punch might backfire. And the biggest limitation for the RBI has been the size of the external reserves, which has been coming down. That, in turn, reduces the quantum of ammunition in the hands of the RBI.

Government spokespersons are right in saying there is no need for panic. But it is all too evident that there is no magic wand to wave the marauding dollar away.

It’s not rupee weakness but …

Various explanations exist as to why India is not unique with its currency problem. Almost all emerging market currencies are under pressure too, with some like the South African Rand declining to an even greater degree against the dollar.

That has prompted some analysts to conclude that it is not the rupee’s weakness so much as the dollar’s strength that is behind the currency depreciation. Such a conclusion is untenable. It is true that the American economy is showing signs of recovery. But the dollar has also gained on the belief that the American Federal Reserve that had unleashed an unprecedented quantitative easing programme might end it sooner than expected. The programme essentially targeted the floundering domestic economy by making available plenty of cheap money. Some of it flowed to countries such as India. If the programme ends, there is every likelihood of the capital flows going back to the U.S. to fund the revival.

Available statistics with the government show that both the debt market and the equities have witnessed a reverse flow of money. The fear is that the tempo of the outward flows might increase in the coming days.

Even though the latest saga of rupee depreciation has yet to work itself out, a few points merit attention. One, India’s external reserves, now $290 billion, are not export earnings but dollars accumulated by the RBI when it mopped up dollars coming in through short-term flows. Therefore, bulk of the reserves is in the nature of debt and do not “belong” to the country. They will have to be treated with lot more circumspection than in the past when a portion of the reserves were, quite controversially, used as seed money for infrastructure funds. That was sheer bad policy making but then in India there is no accountability for bad advice.

Short sightedness

Closely related is the extreme short sightedness of the UPA II in encouraging short-term external commercial borrowing by companies on the mistaken belief that the surfeit of money and the very low interest rates will prevail indefinitely. Obviously, the government had blithely ignored the most obvious risks arising out of currencies and asset-liability mismatches. Already the chickens are coming home to roost.

narasimhan.crl@thehindu.co.in